Egypt’s economic environment is conducive to an accelerated easing cycle, which should trigger loan growth but reflect in lower net interest margin (NIM), according to the research department at HC Securities and Investments.

Following the Egyptian Pound floatation in November 2016, the Monetary Policy Committee (MPC) of the Central Bank of Egypt (CBE) hiked policy rates a total 700 bps, resulting in a slowdown in private lending. With economic improvements, the MPC cut rates consecutively in February and March 2018 a total 200 bps before cutting another 100 bps this February.

According to surveys conducted by banks, private businesses are looking for a further 300–400 bps cut before resuming capital expenditure (CAPEX) borrowing.

Interest rate expected to fall by 1-2% before year-end

HC anticipates that inflationary pressures will subside following the full removal of gasoline subsidies. Monette Doss, banking analyst at HC research department, expects the CBE to accelerate its planned rate cuts, with a possible 100–200 bps cut in the second half (H2) of 2019e before another 200–300 cut bps in 2020e, fully reversing the initial 700 bps hike.

Before the last CBE meeting on Thursday, in which it decided to cut interest rates by 1.5%, Doss said that this should take average NIMs for banks under coverage to 4.5-5.0% by 2024e from 5.5-6.9% over the fiscal year (FY) 2017/18.

“Strong asset quality and capital base for banks under coverage accommodate for a stricter regulatory environment: Egyptian banks started reporting their financial statements according to IFRS 9 accounting standards in the first quarter (Q1) of 2019, with banks now having to take provisions for expected future credit losses rather than based on historical performance of the credit facilities,” she said.

She added that effect of final amendments to income tax law on treasuries largely mitigated (compared to initial draft), in her view. The final version of the tax law amendments entails separating the tax accounting of a bank’s income from treasuries from all other income. The cost of treasuries will now be calculated by multiplying the bank’s cost to income ratio (excluding provisions and depreciation charges) by 80% of treasury income, with a maximum of 70% of treasury revenue for 2019, 85% for 2020, and 100% of for the following years.

She noted that the amendments became effective on 17 May 2019, and will be applied on treasuries issued since 21 February 2019 as well as treasury re-openings since that date.

“On our numbers, the amendments should raise the effective tax rate for banks under coverage to range 26-31% over our forecast period from 21-28% in 1Q19, prior to the application of the law,” she stressed.

NIMs

Credit Agricole Egypt’s and Abu Dhabi Islamic Bank’s (ADIB) NIMs should outperform the Commercial International Bank’s (CIB) over 2019-24e due to higher proportion of local currency loans, in her view.

“The resumption of monetary easing should reflect in NIMS cooling off across banks under coverage, with CIB averaging 4.9% over 2020-24. We expect Credit Agricole and ADIB, however, to outperform, with average NIMs of 5.4% and 5.2%, respectively, over our forecast period, driven by higher interest-earning, local currency loans as a percentage of total loans. We also expect banks to lengthen their deposit duration to be able to finance CAPEX lending without breaching the maximum interest rate risk imposed by the CBE (15% of Tier-1 capital). This should reflect in tightened interest rate spreads to average 4.6% in 2024e from 6.3% in 2019e,” Doss said.

HC expects a loan compound annual growth rate (CAGR) of 22% for CIB and 18% for both Credit Agricole and ADIB over 2019-24, with the banks allocating less to government treasuries. It also expects the pickup in private lending following the resumption of the easing cycle to be the main balance sheet growth driver for CIB and CAE given their strong capital adequacy ratios (CAR).

“On our numbers, we expect CIB’s CAR to decline to 18.4% in 2024e from 22.6% in 2019e, CAE’s CAR to decline to 14.3% in 2024e from 18.5% in 2019e, well above the CBE minimum requirement of 14.5% and 12.5% for both banks, respectively. For ADIB, we see the capital increase expected by management to take place in 2020 and the reversal of its net retained loss position to support the bank’s CAR, which we expect to reach 15.9% in 2024e.

Effective tax rates

Doss said that CIB, Credit Agricole, and ADIB should show average 2019-24e effective tax rates of 29%, 26%, and 31%, respectively.

“Banks under our coverage display strong asset quality, but we maintain conservative provisioning for all 3 banks reflecting a stricter regulatory environment: We expect NPLs to decline to 4.0% in 2021e for CIB and to be maintained at 3.0% for Credit Agricole, with average 2019-24e coverage ratios of c178% and c154%, respectively. On our numbers, this should translate to average 2019–24e provision charges of 8.9% of operating profit for CIB and 8.3% for Credit Agricole. As discussed in our 20 June ADIB update, we expect the bank’s NPLs to increase to 4.0% in 2022 from 2.5% in 1Q19, converging to the banking sector average. ADIB’s coverage ratio stood at c141% as of 1Q19 and we expect it to reach 150% in 2024e, translating to an average 2019-24e provisioning charge of 24% of net operating profit,” she explained.

Relative weight for banks’ shares

Doss recommended downgrade to Neutral for CAE, maintain Overweight for CIB and ADIB. “We value the banks using an excess-return-based model and adopt a moving cost of equity, she said. Accordingly, we raise our 12-month target price c8% for CIB to EGP 87.8/share, which puts the bank at a 2019e P/B multiple of 2.67x. We therefore maintain our Overweight rating, with the stock trading a 2019e P/B multiple of 2.16x. As for CAE, our 12-month target price of EGP 51.9/share puts the bank at a 2019e P/B multiple of 2.3x and we downgrade our rating to Neutral, with the stock trading at a 2019e P/B multiple of 1.95x.”

Moreover, HC estimates the terminal value of CAE using its 10-year average trading P/B multiple of 2.2x. Finally, for ADIB, HC maintains its 12-month target price at EGP 18.3/share, which puts it at a post rights issue 2019e P/B multiple of 1.75x. “We therefore reiterate our Overweight rating. ADIB is our top pick, trading at a post rights issue 2019e P/B multiple of 1.1x. In our view, ADIB offers the highest potential return as its turnaround story is not fully priced in,” Doss said.